Lawmakers Consider Carried Interest Legislation

As lawmakers in Washington mull legislation that will affect the tax treatment of carried interest, a standard form of compensation for general partners in limited partnerships and limited liability corporations, commercial real estate pros are debating whether the legislation makes sense and how much of an impact it will have, should it come to pass.

The proposed legislation would treat part or all of a partnership’s carried interest as regular income, as opposed to a capital gain. The legislation is primarily aimed at private equity funds and venture capitalists, but would have a huge knock-on effect on commercial real estate since many property investments are structured as LPs and LLCs. Carried interest is the portion of the venture profits paid to general partners of such structures after the property has been sold, separate from the fees the general partners earn for managing the property.

For example, if the partnership buys a regional mall for $100 million in 2010 and sells it for $130 million in 2017, the general partners would get a share of the $30 million upside, which would then be taxed as carried interest.

If the legislation passes, the tax rate on carried interest would rise from the current 15 percent to 35 percent—the current highest income tax rate. However, should President Obama go through with the plan to let Bush-era tax cuts expire in 2011, the tax rate would be even higher—39.6 percent. Many industry trade groups, including ICSC, have made the case that higher taxes on carried interest would make real estate transactions less attractive and derail the nascent recovery in the commercial real estate market.

But brokers, tax lawyers and economists say that while the legislation will alter investments in real estate partnerships, it will not have an Armageddon-like effect on the industry as a whole.